Biotech stocks have been some of the fastest growing parts of the market over the past three years but also subject to a number of significant corrections over the same period.
According to FE Analytics, the £431m Axa Framlington Biotech has been the best performing fund over the past three years as well as the most viewed on FE Trustnet over the past month. The MSCI World Biotechnology index has also been one of the best performing indices, gaining 239.96 over three years.
Performance of fund and indices over 3yrs
Source: FE AnalyticsThe fund, managed by Linden Thomson since July 2012, has largely matched the NASDAQ Biotechnology index in terms of performance, as well as volatility and maximum drawdown over the past five years.
The popularity of the fund on our site may be linked to its substantial recent performance, posing the question of whether investors have been – at least thinking of – buying on past performance.
Chris Wise (pictured), managing director of Gemmell Financial Services and an AFI panellist, says buying a fund such as Axa Framlington Biotech after such a good run, and particularly with biotech’s renowned volatility, is highly risky.
“Looking at general equity valuations, not many are looking cheap. However, particularly as this sector has been doing so well, it will be a lot more difficult to get the returns from the fund that you have just had,” he said.
“It will also be more susceptible to suffer a deeper correction than the broader market, in the event of a down period.”
While buying because of recent past performance is rarely a good idea, it can be especially unsuited to more volatile sectors such as biotech, as Wise notes. Experts have questioned how far the bull run in these stocks has left to run.
Kelly says valuations in the biotech market are stretched and the wider sector could see a correction in the coming months.
“Markets have been on a very bullish run recently and something as volatile [as biotech] has been lifted along with that, but there is volatility associated with the industry and that is something an investor must bear in mind,” she said.
“If you are going to try and take advantage of the move in it you can probably expect to see a good deal of noise and potential volatility in the coming months.”
“Valuations may be a bit stretched but as long as there are fears of Ebola there will be an attraction for biotech stocks given the demand we have seen over the past six months. However, given a 40 per cent gain over the past six months there could be a correction due. We have seen biotech exchange traded funds make 20 per cent in the past few weeks alone.”
The death toll from the Ebola virus has risen to more than 5,000, almost entirely affecting West Africa although a few fatalities have occurred in Europe and the US. However, the threat of contagion has reached a global audience, causing governments all around the world to take precautions.
The effect on broader markets has been hard ascertain although a host of fund managers FE Trustnet has spoken to over the past few months have highlighted their concerns about the virus.
However, Kelly says the tragedy has caused an uptick in biotechnology stocks, particularly following the first death outside of Africa which – rightly or wrongly – was interpreted that the crisis could turn into a pandemic.
“Biotech has been a very volatile sector and is seen as so by investors and a bit risky and speculative, and there are many who would be happy to just stay in big pharma, companies such as Pfizer,” she said.
“However there has been a degree of outperformance, particularity in the past few weeks mainly owing to the growth in Obamacare via insurance and in some respects due to the Ebola crisis. The stocks rose initially when the first case was diagnosed in the US last month.”
Biotech stocks have soared this year in comparison to the wider market. The MSCI World Biotechnology index is up 40.97 per cent compared to the MSCI World is up 7.01 per cent.
Performance of indices in 2014
Source: FE Analytics
The sharpest uptick started around the same time as other markets began bottoming out following the recent correction but also coincided with the first US case of the disease.
Kelly says there may be a connection between public concern and investors’ willingness to buy up more exposure to the sector.
“If you look at some of the stocks, particularly in the US such as Sage Therapeutic which investing in Ebola therapies and having an IPO a few months ago and is held by numerous hedge funds, they have very well.”
FE Alpha Manager David Coombs, head of multi-asset at Rathbones, says the initial broad rationale for investment in the sector was that biotech is a theme set to dominate healthcare in years to come.
He has bought the Biotech Growth Trust as a long-term play on this theme and added to the holding during to the recent sell-off.
The trust has returned 283.65 per cent, beating both its sector and index by more than 45 percentage points.
Performance of trust, sector and index over 3yrs
Source: FE Analytics
The trust is currently on a 5.6 per cent discount and has gearing of 8 per cent. It has ongoing charges plus its most recent performance fee amounted to 2.09 per cent.
Ian Mortimer, manager of Guinness Global Equity Income, also thinks the biotech sector could fall victim to a decline given where valuations are for certain companies.
"It’s getting to the stage where investors are paying up for a product that they don't know will actually come to market,” he said.
“Some are in phase two of development, and still need to go to stage three and then come to market. It’s basically impossible to price them – at least you can price Twitter and Facebook."
Kelly says the sector is for very growth focused investors looking for the next big thing only.
“You are taking a risk that there will be a reward that will go along with the risk. They need to buy it from a longer term buy and hold stance, not as a shorter trade. There is a great deal of profit to make and depending on your investment horizon and tolerance for risk it is important to have some exposure.”
“However, you certainly wouldn’t want a lot of exposure of your portfolio to such a niche and volatile sector.”